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A serious essay on the need to retire our old arguments and economic thinking.
It is time that we, all of humanity, stopped using 18th-century economic paradigm(s) to solve vastly different 21st-century challenges. For starters, the global population has grown 10-fold from about 800 million people in 1750 to an estimated 8 billion people in 2022. If ten people moved into your house with you, you likely would need a vastly different set of house rules.
U.N. Secretary General, António Guterres, called the latest climate study “a code red for humanity.” In a report released some weeks ago, the Pentagon asserted that “increasing temperatures; changing precipitation patterns; and more frequent, intense, and unpredictable extreme weather conditions caused by climate change are exacerbating existing risks” for the United States. And yet? Most standard forecasts for the economy overlook those existing risks and the “code red” conditions which will impact our social and economic well-being for decades to come [1].
Human activities since the beginning of the Industrial Revolution, approximately the mid-1700s, have resulted in an increase in the carbon dioxide content of the Earths’ atmosphere of about 48 percent so far; including all greenhouse gases the change from natural levels is 80 percent [2]. The graphic below suggests that, however else we might want to think about it, this is a serious disruption to climate stability that’s increasing every year. If we reach a 100 percent change—and we are on the that path today—climate catastrophes are clearly in the forecasts.
Source: https://gml.noaa.gov/aggi/aggi.fig4.png (accessed November 2, 2021).
So the question: Why does Adam Smith’s 1776 book, The Wealth of Nations, still form the basis for much of our economic thinking in the 21st century? Smith has been called “the father of economics” [3], and his book has been called “the original text that defined market discourse” [4].
We believe an important reason is its leading-edge whole system approach to understanding an emerging economic worldview at the time, loosely called free-market capitalism. That model might have been appropriate for 1776 but with the dynamics of climate change and other current “Code Red” conditions, we must step back and embrace a more appropriate economic model for the 21st century, where critical challenges are critically different from the 18th century. We stand on the shoulders of brilliant, creative whole-system thinkers like Kenneth Boulding, Herman Daly, Hazel Henderson and more recently Kate Raworth, and countless others. Robert U. Ayres talks about the importance of understanding “energy as work” rather than energy as a mere commodity sold in the market at some price. Mariana Mazzacuto, for example, today asks the fundamental question: What is economic value and who creates it?
Where does the “rubber meet the road?” What differences would a different economic model mean for actual governance and private sector decision-making? And would better decisions result from a different macroeconomic perspective? We believe the answer is yes, and that existing economic models have deficiencies that point to an apparently greater cost compared to the many benefits which might otherwise accrue to humanity.
To be clear, we are not talking about capitalism vs. planned economies (e.g. Chinese Market Socialism, whatever that is). The world’s economies are so integrated, and mixed between “socialism” (strictly speaking, meaning ownership of the means of production by the community as a whole) and capitalism (meaning the private ownership of the means of production), that distinctions between pure socialism and capitalism aren’t especially meaningful in today’s global economy [5].
On the other hand, we are talking about understanding economies in the context of Earth’s physics and ecosystems, both of which are “givens” to humankind rather than humankind-created realities. This different view seems to have many more benefits than costs at this precarious point of our existence.
The most basic concept is wealth creation. For some reason(s), assumptions about the importance of labor versus capital versus resources have been important to economists – for example, both Sir William Petty, but also Karl Marx’s “Labor Theory of Value” was an important basis for conclusions about socialism/communism being a more humanitarian-advanced state of economic management than free-market capitalism.
But underneath such perspective is a basic physical relationship: human wealth is produced when energy is used to take something from nature, and then transform it to something of value for humanity. Whether it is a fish being converted into human nourishment, or an acre of grasslands being converted to the growth of crops or urban development, or gold flakes in a streambed becoming gold bars people will pay good money for, something of nature is being converted to something of value to humans. That initial wealth creation gets distributed such that many services we desire, like a haircut, add value to humanity without converting nature per se – but the wealth that allowed us to pay for that haircut ultimately came from something of nature being converted to human value.
When we convert nature to human value, we are investing energy and materials into that process, hoping the result will be more benefit than cost. Unfortunately, our “cost” calculations are often inaccurate – when we count only the immediate costs we are saddled with in a given market system at the time, we can delude ourselves that our activities are, for humanity more generally, more benefit than cost. In other words, our loose accounting for costs stimulates us (whether working for a government-owned operation like a military or state-owned petroleum company or working for a fully private enterprise or just ourselves) to become an “externalizing machine” regarding our costs. In other words, we are highly incentivized to push the costs of our conversion of nature out of our cost calculations and onto others – and thus we can compete on a price comparison basis.
Adam Smith’s whole system of economic decisions imagined that with people acting freely and competing on a cost-basis, humanity would benefit because the market’s “invisible hand” sorts out who is creating wealth more efficiently than others, and surmises that humanity benefits if only the most efficient wealth creators in a competitive market ultimately survive – thus maximizing economic efficiency in that our resources flow towards the most efficient providers of what humans want (as measured by what humans will pay for).
But Smith’s system is fundamentally based on prices, the language of capitalism, being accurate enough to perform this distribution function pretty accurately. It can achieve “failure mode” as a system if prices don’t reveal the truth. And sadly, they don’t.
Where prices tell the least amount of truth is where considerations of physics and ecology come into play. And as humanity is reaching, or has reached real limits of physics and ecology and may face dire consequences as a result (e.g. “overshoot and collapse”) [6], it is a critical time to rethink how we understand our economy so we can best manage it for its optimal outcomes (e.g. the most number of people are secure and happy).
This call for a new economic “paradigm” echoes similar calls of the past 50 years. It resembles the insights of Ayres of how technology advances – i.e. an existing technology reaches its limits of usefulness, opening the gates for a superior technology to be needed, invented and spread around. We have reached the usefulness of traditional (aka Neoclassical) economics partly because it doesn’t take physics and ecology into account, but physics and ecology are now our most important limits (whereas in 1776, capital formation and investment was arguably the most important limit and governments addressed these limits with increasingly loose requirements on private corporations that could accumulate the capital needed to build transportation systems, communication systems, and global minerals/energy/food systems).
As Einstein noted, “no problem can be solved from the same level of consciousness that created it.” Or in close synch from Donella (Dana) Meadows: the most effective places to intervene in a system are “the power to transcend paradigms” followed by “the mindset or paradigm out of which the system – its goals, structure, rules, delays, parameters – arises.” [7]
Humanity’s critical eco-social crises deserved system intervention decades ago in the late 20th century—if we were to give ourselves the best chance of avoiding the huge and unnecessary traumas from having to deal with them today. Now even deeper changes are required today. We have the knowledge to transition to economic understandings based on physics and ecology – we just need to get with it. With a hint of what is to come. . .
Can business executives make good decisions without better data on what is profitable? Of course not. And in the same way economic and other social metrics – ones that reflect the physical energy flows and ecological costs which underpin our wealth creation activities – need to be implemented in quick order to allow us to be much more effective managers.
For example, rather than merely track the sale energy as mere commodities sold on the market at some prices, we must explore the positive link between the more productive use of all energy resources as they enable a more robust and sustainable real per capita income.[8]
Governments and businesses trying to make a profit within the government’s economic strictures (aka the business climate of taxes, infrastructure, trade agreements, labor rules and supply, etc.) need more accurate measurements to build a sustainable future with. It is time for the work to develop these concepts and indicators over the past six plus decades to now be embraced and actually be put to work!
[2] Atmospheric CO2 levels prior to the Industrial Revolution in the late 1700s were ~280 parts per million (ppm). They are presently 414 ppm, a ~48% increase. Carbon dioxide is just one of the greenhouse gases emitted by humanity; according to US NOAA, the carbon-dioxide equivalent concentration of all GHGs is presently ~500 ppm; see https://gml.noaa.gov/aggi/aggi.fig4.png. For daily CO2 tracking see: https://www.co2.earth/daily-co2
[3] Jesse Norman, a Conservative U.K. Parliamentarian, published in 2018 a new biography of Smith is titled Adam Smith – Father of Economics (2018). Norman noted that Smith was not “someone who felt that markets should have no regulation at all,” quoted in William Watts, “Busting Myths About Adam Smith, free markets and the invisible hand,” MarketWatch website, 20 Sept. 2018, at: https://www.marketwatch.com/story/busting-myths-about-adam-smith-free-markets-and-the-invisible-hand-2018-09-18
[4] Deborah Boucoyannis, “Contrary to popular and academic belief, Adam Smith did not accept inequality as a necessary trade-off for a more prosperous economy,” 2014, at: https://blogs.lse.ac.uk/politicsandpolicy/adam-smith-and-inequality/. Ms. Boucoyannis was Assistant Professor at the Woodrow Wilson Department of Politics, University of Virginia at the time of publication. She summarized Smith’s capitalist system that would maximize the “wealth of nations” as: “profits should be low and labor wages high; land should be distributed widely and evenly; inheritance laws should partition fortunes; taxation can be high if it is equitable; and the science of the legislator is necessary to thwart rentiers and manipulators.” In Boucovannis’ opinion, “The key principles of Smith’s system work against the concentration of wealth.”
[5] See, for example, Ian Bremmer, The End of the Free Market – Who Wins the War Between States and Corporations? 2010. https://journals.sagepub.com/doi/full/10.1007/s12290-010-0129-z
[6] Donella H. Meadows et.al., The Limits to Growth – a Report to the Club of Rome, Potomac Associates, 1972; pdf available at: https://www.clubofrome.org/publication/the-limits-to-growth/
[7] Academy for Systems Change, The Donella Meadows Project, “Leverage Points – Places to Intervene in a System,” accessed October 2021, at: https://donellameadows.org/archives/leverage-points-places-to-intervene-in-a-system/
[8] Laitner, John A. “Skip”. March 2021. Memorandum on Energy as Work: Estimating Exergy Efficiency for the U.S. and the Global Economy, at: https://theresourceimperative.com/wp-content/uploads/2021/03/Memorandum-on-Energy-as-Work.pdf. . . But for a deeper dive into the broad physics of it all, you might check out: Steve Keen, Robert U. Ayres, and Russell Standish. 2019. “A Note on the Role of Energy in Production.” Ecological Economics. Volume 157, Pages 40-46. https://www.sciencedirect.com/science/article/pii/S0921800917311746
There is neither a law of physics nor economics that prevents us from quadrupling the productive use of energy and other resources. Rather, it is much more an issue of imagination and our political will to get it done.
– John A. “Skip” Laitner
